In this part of our series on the credit for increasing research activities (research credit), we’ll take a look at the type of expenses which qualify for the credit.
(For Part 1 of this series discussing what constitutes qualified research, click here.)
Qualified Research Expenses
In order to qualify for the research credit, an expense must fall into one of the following categories:
- Wages paid to employees for qualified services. That is, they are engaged directly in qualified research or engaged in the direct supervision or direct support of qualified research activities. For example, wages paid to an employee who designs an experiment, who conducts a test or who types a research report are qualified research expenses. However, the wages of an employee preparing the paycheck for those individuals engaged in qualified research are not qualified research expenses. If 80% or more of an employee’s time is spent on qualified research, all of that employee’s wages are eligible expenses. Otherwise, an allocation must be made between qualified research and other duties. For self-employed individuals and owner-employees, “wages” includes the earned income of such employees. Wages used in determining the work opportunity credit may not be included in the amount of wages for qualified research expenses.
- Supplies used specifically in conducting qualified research. Supplies include any tangible property other than land, improvements to land, and depreciable property.
- Amounts paid or incurred for the rental or lease of computers used in qualified research. The computers must be owned and operated by someone else and located on someone else’s premises. Likewise, you cannot be the primary user of the computers.
- Contract research expenses are defined as 65% of the amount paid to any person, other than an employee, for qualified research or services which, if performed by your employees, would constitute qualified services. You are allowed to treat as contract research expenses 75% of amounts paid for qualified research to certain tax-exempt organizations organized and operated primarily to conduct scientific research. In addition, you are allowed to treat as contract research expenses 100% of amounts paid for qualified energy research to certain small businesses, an institution of higher education, and an organization that is a Federal laboratory. Prepaid amounts for contract research expenses are treated as incurred during the period in which the research is conducted.
As noted above, expenditures for tangible property that are depreciable property are not qualified research expenses. As a result, the actual material and labor costs of constructing and installing depreciable property owned by you may not be considered as a qualifying expense. For example, if you spend $100,000 to design and build a new machine for use in your business, and $40,000 of the total cost represents the actual material and labor costs to construct the machine, only $60,000 of the total (which might consist of engineering, contract labor, and the like) is considered to be for qualified research. However, certain expenditures for tangible property, such as costs of production tooling or molds, produced for and sold to a customer, may be considered qualified research expenses, assuming the expenditures satisfy all of the other requirements.
Qualified research activity must also involve an element of risk to you. If an expense is paid or incurred pursuant to an agreement under which payment is contingent on the success of the research, the expense is not a qualified research expense.
Contact Edwards, Ellis & Associates to learn more about the research credit and how it can benefit your business.
